Trader Talk

Hillary Clinton's financial transaction tax: Why it may not work

U.S. Presidential candidate Hillary Clinton and U.S. Senator and former presidential candidate Bernie Sanders
Keith Bedford | The Boston Globe | Getty Images

The focus will now shift to Hillary Clinton's economic plans. Among them: a financial transaction tax (FTT) on high-frequency trading.

But that's just the start. Bernie Sanders and other Democrats support a broader tax on all financial transactions.

An FTT is a tax on financial transactions, typically on the trading of stocks and bonds. Here's the problem: None of these proposals are likely to accomplish their goal of raising the amount of money claimed or curbing "abusive" behavior. And it could be damaging to trading.

The Democratic Party Platform says: "We support a financial transactions tax on Wall Street to curb excessive speculation and high-frequency trading, which has threatened financial markets. We acknowledge that there is room within our party for a diversity of views on a broader financial transactions tax."

Hillary Clinton's plan is short on details, but she says that high frequency trading "has unnecessarily burdened our markets and enabled unfair and abusive trading strategies that often capitalize on a 'two-tiered' market structure with obsolete rules."

She has proposed a tax on cancelled orders only, which is unlikely to generate any revenue. It's also strange because if the goal is to curb spoofing, it's already illegal and was made so under Dodd-Frank.

Would there be any harm to taxing cancellations? It's not clear, but an argument could be made it would lead to higher costs. Presumably, there would be some quota of untaxed allocations that would be permitted. To avoid going over the quota and paying the tax, HFTs would want to avoid paying the tax, so they may not provide bids and offers with the same regularity. That could lead to wider bid-ask spreads.

Clinton has not floated any specific tax level and it seems unlikely this would generate much revenue. That may or may not bean issue for Hillary Clinton, but it is certainly an issue for other Democrats,particularly Bernie Sanders.

Last year, Bernie Sanders introduced a bill (S. 1371) for a financial transaction tax, the proceeds of which would be used to make public colleges and universities tuition free. Under his proposal, trades would be taxed at a rate of 0.5 percent for stocks, 0.1 percent for bonds, and 0.005 percent for derivatives.

That works out to $5.00 for every $1,000 of stocks that trade. That is a lot of tax.

Let's take an example of someone who buys 100 shares of IBM at the market price of, say, $160. That's $16,000. The tax would be $80. That is not a trivial sum.

Bear in mind that roughly $300-$400 billion in stock changes hands every day, so we're talking about a lot of money that could potentially be raised.

Sanders proposal contains an interesting loophole: Should brokerage houses try to pass on the cost of the tax to their customers(as they surely will), Sander would provide a tax credit to individuals making under $50,000 and couples making under $75,000 to ensure that they would not be impacted.

There are other proposals floating around as well. Last Wednesday Representative Peter Defazio (D, OR) introduced a bill that would place a speculation fee of 0.03 percent on credit default swaps, derivatives, stocks, bonds, and other financial transactions. This is considerably lower than Sanders' proposal but would still raise an estimated $417 billion over 10 years.

You get the idea: a lot of proposals, and none of them likely to work as they are supposed to.

There are several problems with a FTT, whether it is a broad one or a targeted one like that proposed by Clinton.

  1. It's been tried and hasn't worked as hoped. The U.S. did impose a tax on stock transactions, for 50 years, from 1914 to 1964. The Revenue Act of 1914 levied a tax of 2 cents per $100 of par value on all sales or transfers of stock (this is far less than Sanders'proposal of 50 cents per $100). The rate was doubled in 1932. A 1934 study concluded that it didn't raise a lot of money and didn't check the speculative activity it claimed it would check. It lingered on for 32 years,collecting little money, until it was killed in 1966. Many other countries do have FTTs of various types. Sweden had an FTT from 1984 to 1991, but it was repealed because so much trading moved offshore. Germany abolished its FTT in 1991 for a similar reason.
  2. It won't raise as much money as everyone thinks. In Italy, which has levied a 0.1 percent tax on bonds, stock, and derivative trades executed on a regulated exchange since 2012, the tax has raised just 159 million euros, well short of the 1 billion euros expected. Investors have apparently switched investments away from purely domestic equities and toward platforms and asset classes that had no tax or lower taxes. France introduced a FTT in 2013, and it was initially predicted it would raise 1.5 billion euros but has raised less than half that.
  3. It will reduce trading and liquidity. There are many studies that note this effect, but recently a group of professors at UMass Amherst predicted that trading could drop 50 percent if Sanders' proposal was adopted.

Even if Clinton wins, the chances this would pass a Republican-controlled House are slim. Still, this is illustrative of the rift between Clinton and her more left-leaning colleagues.

You can bet any call for more taxes on Wall Street will be met with loud cheers, even if an FTT is a tax on investors.